Comparison Rate

A comparison rate is a single percentage that combines a loan's advertised interest rate with most of its fees - establishment fees, annual package fees, monthly account-keeping charges - expressed as one effective annual cost. Australian consumer credit law requires it in every advertisement for a consumer loan, displayed at least as prominently as the headline rate. The number exists because the headline rate is the marketing and the fees are the product: a 5.79 percent rate with a $395 annual fee can cost more than 6.0 percent without.

The standard comparison rate is calculated on a $150,000 loan over 25 years, which is the limitation worth knowing. On a larger loan the fees are a smaller proportion, so the published comparison rate overstates the cost; on a smaller or shorter loan it understates it. Government charges such as stamp duty sit outside the number entirely, and so do fees that depend on your behaviour - break costs, redraw fees and late-payment charges. The comparison rate is the honest starting point, not the complete answer.

Walk the arithmetic. You are quoted $150,000 over 25 years at 5.79 percent, with a $395 annual package fee and a $600 establishment fee. The comparison rate folds the fees into the interest rate and lands at roughly 6.2 percent - the gap between the two numbers is roughly $10,000 over the life of the loan. The comparison rate calculator runs the fold on any loan size and term.

The loan-size limitation is where the number misleads. The $455 of fees is a fixed amount, so on a $500,000 loan it is a smaller proportion and the true comparison lands closer to the headline - the published comparison rate overstates the cost on large loans. On a small balance the same logic runs in reverse. Fees that look minor on a mortgage dominate a small loan: a 6.99 percent headline with a $600 establishment fee and a $15 monthly charge can carry an 8.3 percent comparison rate on a $20,000 car loan.

The excluded items close the loop. Government charges - stamp duty, registration - sit outside the comparison rate, and so do fees triggered by your behaviour: break costs on a fixed loan, redraw fees, late payments. The number is a standardised snapshot, and the fine print is still the fine print. The mortgage calculator prices the full cost on your actual loan.

For an Australian reader, the comparison rate is the law's answer to the advertising department, and it is the only rate worth comparing loans on. The headline rate is a marketing number. The comparison rate folds most of the fees into one annual cost, and the law requires it displayed at least as prominently as the headline in every consumer loan advertisement. MoneySmart's guidance on choosing a home loan is to compare on the comparison rate - on a small loan, the gap between the two numbers can be percentage points, not basis points.

A colleague named Brent (yes, that Brent) chose a 5.59 percent headline over a 5.79 percent clean quote. He never read the $395 annual fee underneath, and paid for the headline every year for the life of the loan. The comparison rate was printed next to the headline the whole time. The highest-leverage thing most Australians can do is read the comparison rate first and the headline second, then run the full cost through the comparison rate calculator on their own loan size - the $150,000 assumption overstates the cost on a large loan.